Banks land bumper profits despite crunch

Britain's banks are forecast to report bumper profits of more than £42bn for 2007 despite being forced to stomach losses caused by the credit crunch.

Bradford & Bingley kicks off the reporting season on Wednesday and will be followed by all the main players, culminating in HSBC on March 3. Stricken lender Northern Rock has yet to set a date to report its figures.

With a backdrop of worsening economic conditions, there are suggestions that 2007 could be the last record year and that the profitability of the banking system is facing its greatest risk in a decade.

Since the financial markets began to dry up in the summer, the way banks finance their lending has shot to the forefront of investors' minds and concerns about the balance sheets of banks are expected to dominate the coming weeks.

John-Paul Crutchley, banks analyst at Merrill Lynch, said: "The reporting season will be about balance sheet issues. It will be about what balance sheets look like, what the funding issues will do for growth and the outlook for 2008."

Any additional write-downs caused by investments in exotic trading instruments linked to the sub-prime mortgage crisis could also unnerve investors. Royal Bank of Scotland and Barclays are of concern and RBS in particular remains mired in speculation that it will need to raise as much as £12.5bn to shore up its capital base after the acquisition of parts of ABN Amro last year. The Barclays Capital investment banking arm may also need to admit to greater losses.

James Hutson, analyst at Keefe Bruyette & Woods, believes "the biggest short-term risk to the sector remains the magnitude of investment write-downs".

The knock-on effect the credit crunch is having on the mortgage market and the wider economy may begin to show in the 2007 figures. Hutson notes that annualised mortgage growth is about 10% compared with five years of growth in the low- to mid-teens.

The slowdown in home loans follows a move by banks 18 months ago to begin to hone down their unsecured loans and credit card operations.

While the financial markets are providing a tricky backdrop for bankers, the regulatory environment is also proving to be testing and could also have a broader impact on banks' income.

A high court judge is hearing a test case on whether banks can charge overdraft fees on current accounts and his decision, expected next month, could also reduce the amount of income earned by banks from retail customers. Banks have already coughed up more than £500m to more than 300,000 people claiming they wrongly paid overdraft fees and that bill could rise if the judge decides they should never have been levied.

Perhaps more than ever, any indication from the banks of their outlook for 2008 will be closely monitored for indications of the extent of the slowdown. Any reduction in their cashflow could signal that dividend payments will be under threat.

"Longer term there is more risk surrounding the outlook for earnings than at any time in the last 10 years," said Hutson.

In the short term, however, the dividends payments that the banks are expected to announce and the clarity over write-downs will lend some support to the sector, he said. The banks will able to finance their dividends from their current cash flows.